How Short-Term Supply Constraints Will Impact Booming HEV Markets

John Petersen

For several weeks I've been writing about robust demand in Europe for a new class of HEVs that are usually
referred to as "stop-start" or "micro hybrids." According to the EPA's
website:

"Stop/Start hybrids
are not true hybrids since electricity from the battery is not used to
propel the vehicle. However, the Stop/Start feature is an important,
energy-saving building block used in hybrid vehicles.

Stop/Start technology conserves energy by shutting off the gasoline
engine when the vehicle is at rest, such as at a traffic light, and
automatically re-starting it when the driver pushes the gas pedal to go
forward."

The concept is simple and so is the technology. Adding micro hybrid
capabilities at the factory typically costs less than $1,000 per
vehicle and improves fuel efficiency by an estimated 5% to 8%. It's
a baby step, but as my first table in The
Obama Fast Track for HEVs shows, it's more cost-effective than any
other class of HEV technology. The main reason micro hybrids are so
affordable is
that they use advanced lead-acid batteries instead of more expensive
alternatives.

Since the booming European micro hybrid phenomenon has not reached the
U.S., a couple skeptical readers challenged me to show them press
releases from major European OEMs announcing plans to produce HEVs
that didn't use NiMH or Li-ion batteries. They were not
satisfied with my initial response that micro hybrids are being adopted
as standard equipment without major fanfare. Yesterday
I found an October 2008 "Power
Solutions Backgrounder" from Johnson Controls, Inc. (JCI)
that proves the point nicely:

"We sold 400,000 advanced batteries for
start/stop micro hybrid vehicles in Europe in 2007 and 800,000 in 2008,
with the expectation of doubling that number again in 2009 to
approximately 1.5 million batteries. These vehicles achieve a 5 percent
to 8 percent fuel savings compared to conventional gas vehicles."

I then found www.hybridcars.com,
a rich source of data that describes itself as the
Internet’s premier website dedicated to hybrid gas-electric vehicles.
By combining the micro hybrid battery
sales data from JCI with additional data from hybridcars.com,
I was able
to cobble together the following graph that shows the growth of the
global HEV market over the last 10 years. Since I don't have
access to comprehensive data on the European micro hybrid market, I
assumed that JCI was the only competitor. As a result, the
graph understates European micro hybrid sales by a couple of percentage
points, but in
this case shape is far more important than numerical precision.

With historical data to provide context, the following
graph from a 2008 Frost
& Sullivan presentation that summarizes their forecast of
future growth in global HEV sales makes a good deal more sense than it
may have in earlier articles.

As I explained in How
Growing HEV Markets Will Impact Battery Manufacturing Revenues, the
Frost & Sullivan forecast was based solely on European CO2
tailpipe emission standards that take effect in 2012 and did not
account for President Obama's subsequent acceleration of CAFE
standards. That recent change will have the effect of pushing growth
that would normally have occurred in the 2015 to 2020 timeframe into
earlier years and could easily double the growth rates that were
expected last fall. While I'm happy to leave the work of updating
growth forecasts to experts like Frost & Sullivan, it seems safe to
conclude that the next few years will be a challenging time for the
battery industry.

Under the growth scenario presented in the Frost & Sullivan graph,
the bulk of the unit growth in the HEV markets will go to lead-acid
battery manufacturers who will not need to make larger numbers of
batteries, but will need to make higher quality batteries that are
better suited to the performance requirements of micro hybrids. This
changing product mix will reduce production volumes for low-margin valve regulated lead-acid
batteries and increase production volumes for high-margin advanced lead-acid
batteries, and should lead to rapid and sustained revenue and profit growth for
all lead-acid battery producers.

As we move away from the micro hybrid market and focus on the higher
value markets for mild, full and plug-in hybrids, the challenges become
more daunting. Jack Lifton
has written several articles on global production constraints for the
rare earth metal lanthanum; the "M" in NiMH batteries. His basic
concerns are that substantially all of the world's supply of rare earth
metals comes from China; their current production of roughly 33,000
tons of lanthanum per year can only provide raw materials for about a
million HEV battery packs; and their domestic demand for rare earth
metals is growing at an extraordinary rate that will limit future
exports. Since it usually takes several years to increase production
from an existing mine and even longer to bring a new mine into
production, Jack expects the battery industry to encounter substantial
short- to medium-term bottlenecks in the lanthanum supply chain. If
he's right, automakers will be forced to make a Hobson's choice for
an increasing percentage of their HEV battery needs:

Use Li-ion batteries despite the performance, cost, abuse
tolerance and cycle life concerns; or

Use advanced lead-acid batteries despite the weight and volume
concerns.

On its face this seems to be good news for Li-ion battery developers
like Ener1 (HEV),
Valence Technology (VLNC)
and Altair Nanotechnologies (ALTI)
who consistently argue that their proposed products are best choice to
fill the gap between surging HEV demand and constrained NiMH battery
supply. While many find those arguments persuasive if not compelling, I
remain skeptical for several reasons.

First, Li-ion batteries have a checkered history in portable
electronics that are used indoors. We know almost nothing about their
long-term performance when exposed to the heat, cold, moisture,
vibration, driving habits, user neglect and physical stress that automobiles have to endure on a daily basis.
The only way to develop that knowledge base will be to get Li-ion
batteries out of the laboratory and into test fleets. While many
automakers have announced plans to begin limited production of HEVs and
PHEVs that use Li-ion traction batteries over the next two years, I
can't help but wonder whether the Li-ion battery sector isn't in
exactly the same position that the NiMH battery sector was in 10 years
ago. My next graph comes from the May
2009 Dashboard at hybridcars.com and shows the 10-year U.S. sales
history for HEVs with NiMH batteries. Call me a luddite, but I have a
hard time accepting the idea that HEVs with Li-ion batteries will
follow a
development path that goes from zero vehicles per year to hundreds of thousands of
vehicles per year over the course of four or five years. From all of the projections I've seen, the DOE and all major automakers share those reservations.

Second, the world's productive capacity for the large-format Li-ion
batteries that are needed for automotive applications is very limited.
There have been numerous announcements about plans to
build new factories, but the bulk of those planned facilities will not
be operational until 2011 or 2012. Since most existing Li-ion battery
plants are already running at full capacity to make batteries for the
high value portable electronics markets, I don't believe Li-ion
batteries will be able to make a meaningful contribution to the auto
industry's drive to meet European CO2 emission standards
by 2012.

Third, I remain concerned that global rates of lithium production will
not be able to keep pace with rapidly increasing demand for batteries. According to USGS
publications, approximately 25% of global lithium production is
used for Li-ion batteries. While global lithium production
has grown at an annual rate of roughly 6% over the last couple of years
to a 2008 total of 27,400 tons, the production process for lithium from
brines involves an 18-month evaporation cycle before the alkali salts
contained in the brine are ready for separation, refining, processing and use.
Moreover lithium mining is subject to the same expansion constraints as
other extractive industries. I'm no longer worried about the long-term
adequacy of global lithium resources and I know that production can be expanded over time, but production capacity cannot be
expanded quickly and there are certain to be substantial short- to
medium-term production bottlenecks.

Automakers are a conservative lot and they are intensely sensitive to
price, performance and supply chain issues. They understand that NiMH
and Li-ion battery supplies are constrained by limited global
production of
lanthanum and lithium, and that large format Li-ion battery supplies
will be further constrained for several
years by inadequate manufacturing capacity. They also have substantial
reservations about the
long-term performance of Li-ion batteries under the extreme heat, cold,
humidity and
vibration conditions that automobiles have to endure on a daily basis.
Notwithstanding these known and very real business constraints, the
automakers are under strict regulatory edicts to reduce fleet average CO2
emissions to 130 grams per kilometer in Europe by 2012 and improve fuel
economy by roughly 35% in the U.S. by 2016. These are very brief
timeframes for changes of this magnitude.

The end result is an untenable situation where proven NiMH batteries
won't be available in adequate volumes during the regulatory compliance
period and even unproven Li-ion batteries will be subject to daunting
supply constraints. In a nutshell, supply constraints will leave
the booming HEV markets in a critical state of flux for several years.
While
nothing can be predicted with certainty, I believe the likely responses
from automakers will fit in three distinct categories:

Automakers will continue to use proven NiMH batteries as their
preferred
HEV technology until limited lanthanum supplies restrict the
ability to manufacture NiMH batteries;

Automakers will accelerate their efforts to build demonstration
fleets of high value products using unproven Li-ion batteries, but
production
volumes will remain small until they gather enough hard performance
data to justify the widespread commercialization of the technology;
and

Automakers will significantly increase their use of advanced
lead-acid
batteries in high volume budget priced product lines, including mild
and full hybrids that can tolerate the seventy-five pound weight gain and
one
cubic foot space loss that will typically arise from using advanced lead-acid
batteries instead of NiMH or Li-ion.

This is a sub-optimal environment for all parties because automakers do
not have the
flexibility to develop new product lines on a multi-year schedule. They
have to go to work immediately with the tools at their disposal and
bring their product lines into regulatory compliance in a little over five years. The end result will be an accelerated timeline for Li-ion batteries and increased use of advanced lead-acid
batteries in product lines that might have been introduced with NiMH
batteries under more normal conditions. As automakers develop
experience with using both advanced lead-acid and Li-ion batteries in
roughly equivalent applications, the
unanswered technical and cost-benefit questions about which technology
is best for automotive applications will be conclusively answered. In
other words, we're going to have a horse race after all.

DISCLOSURE: Author does not own any of the stocks mentioned in this
article because all of his personal investments are in pure-play
lead-acid battery manufacturers.

John L. Petersen, Esq. is a U.S. lawyer based in Switzerland who works
as a partner in the law firm of Fefer Petersen & Cie and represents
North American, European and Asian clients, principally in the energy
and alternative energy sectors. His international practice is limited
to corporate securities and small company finance, where he focuses on
guiding small growth-oriented companies through the corporate finance
process, beginning with seed stage private placements, continuing
through growth stage private financing and concluding with a reverse
merger or public offering. Mr. Petersen is a 1979 graduate of the Notre
Dame Law School and a 1976 graduate of Arizona State University. He was
admitted to the Texas Bar Association in 1980 and licensed to practice
as a CPA in 1981. From January 2004 through January 2008, he was
securities counsel for and a director of Axion Power International,
Inc. (AXPW.OB)
a small public company involved in advanced lead-carbon battery
research and development.

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Comments

It should probably be noted that your concerns regarding the real world performance of lithium based batteries for automotive applications also applies to the advanced lead-acid batteries. Yes, lead-acid is a known chemistry (mostly). However, there is zero experience with the ability of the advanced technology lead-acid batteries to stand up to the rigors of real world use. While I expect they will ultimately prove to be acceptable, it is too early to tell whether there will be "birthing pains".

With regard to the suitability and likely broad use of micro-hybrids, another consideration is integration with diesel (and HCCI, if they are commercialized) vehicles. Diesel provides higer fuel efficiency at a higher vehicle cost compared to the eqivalent petrol based vehicle. Incorporating micro-hybrid technology with diesels could enable a further improvement in fuel economy at relatively low incremental cost, an effective competitive action versus full hybrids. Further, it adds some marketing "buzz". I would therefore expect broad and quick adoption of micro-hybrid tech to diesels.

There is an immense difference between a new and improved version of a thoroughly known and tested technology, and an unknown and untested technology.

Proving that a second generation lead acid battery is superior to a first generation battery is a walk in the park. Particularly when the same company that made and sold your first generation device will make and sell the second generation device too.